Chapter 4: Managing Taxes

Objectives

• Explain how taxes are administered and classified.

• Describe the concept of the marginal tax rate.

• Determine who should file an income tax return.

Objectives

• Describe the two ways of paying taxes: payroll withholding and estimated taxes.

• Identify the three steps involved in calculating federal income taxes.

• Understand planning strategies to legally avoid overpayment of income taxes.

• Explain the basics of IRS audits.

Taxes on Purchases

State and local taxes are added to the purchase price of goods.

Excise tax is imposed on specific goods and services• Gasoline• Cigarettes• Alcohol• Tires• Air travel• Telephone service

Taxes on Property

Real estate property tax is based on the value of land and buildings.

Personal property taxes on the value of automobiles, boats, furniture, and farm equipment are imposed in some areas.

Taxes on Wealth

Estate tax-imposed on the value of an individual’s property at the time of death.

Inheritance tax-levied on the value of property bequeathed by a deceased individual.

3 Steps in Determining Taxes

1. Determining Adjusted Gross Income

2. Computing Taxable Income

3. Calculating Taxes Owed

What is Tax Management?

• Reduction

• Deferment

• Elimination

ATTENTION!

A PLANNING PROCESS FOR TAX:

• Federal tax laws

• Progressive nature of income tax

• Regressive

• Marginal tax rate

• Effective marginal tax rate

• Average tax rate

Administration/Classification of Income Taxes

Step 1: Determining Adjusted Gross Income (AGI)

Earned Income-money received by personal effort.

Investment Income-money received in the form of dividends, interest, or rent

Passive Income-activities in which you do not actively participate.

Other Income-Alimony, awards, lottery winning, prizes

Other Items That Impact Income

Exclusion-amount not included in gross income.

Tax Exempt Income-another name for exclusions-Qualified scholarships and fellowships where money is used for tuition, fees, supplies, and equipment, VA payments

Tax Deferred Income-income that will be taxed at a later date

Adjusted Gross Income (AGI)-gross income after certain reductions have been made

Tax Shelters-immediate tax benefits and a reasonable expectation of a future financial return (IRA’s Keogh’s)

Taxes on Earnings

Social Security

Income Tax• Federal tax• State tax in all but 7 states

• Alaska• Florida• Nevada• South Dakota• Texas• Washington• Wyoming

Step 2: Computing Taxable Income

Deduction-an amount subtracted from AGI to arrive at taxable income.

• Standard deduction ($5,700/single in 2010)

• Itemized deduction

Exemption-a deduction from AGI for yourself, your spouse, and qualified dependents ($3,650 in 2010)

Step 3: Calculating Taxes Owed

Use your taxable income in conjunction with the appropriate tax table or tax schedule.

Marginal tax rate-the tax on the last dollar of income.

Average tax rate-total tax due divided ty your taxable income.

Tax credit-amounts subtracted from the amount of tax owed.

Tax Payments

Payroll deductions-pay-as-you-go (W-4)

Tax Credit Versus Tax Deduction

$100 tax credit reduces your taxes by $100

$100 tax deduction reduces taxes by your tax bracket. For instance, if a person is in the 25% tax bracket it would reduce your taxes by 25%

W-2

• Earned income

• Unearned income

• Transfer payments

Who Should File a Tax Return?

STUDENTS WITH:

The Progressive Nature of the Federal Income Tax-2010

If your taxable income is:Over:

But notover -- The tax is:

Of theamountover--

$0 $8,375 ------------ 10% $0

8,375 34,000 $837.50 + 15% 8,375

34,000 82,400 4,681.25 + 25% 34,000

82,400 171,850 16,781.25+ 28% 82,400

171,850 373,650 41,827.25 + 33% 171,850

373,650 ---------- 108,421.25 + 35% 373,650

If your filing status is Single

The Tax Rate Schedule is shown so you can see the tax rate that applies to all levels of taxable income. It is not used to figure ones’ taxes.

The Progressive Nature of the Federal Income Tax-2010

If your taxable income is:Over:

But notover -- The tax is:

Of theamountover--

$0 $16,750 ------------ 10% $0

16,750 68,000 $1,675.00 + 15% 16,750

68,000 137,300 9,362.50 + 25% 68,000

137,300 209,250 26,687.50 + 28% 137,300

209,250 373,650 46,833.50 + 33% 209,250

373,650 ---------- 101,085.50 + 35% 373,650

If your filing status is Married filing jointly

The Tax Rate Schedule is shown so you can see the tax rate that applies to all levels of taxable income. It is not used to figure ones’ taxes.